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Most investors turn to Exxon Mobile (NYSE:XOM), Chevron (NYSE:CVX), or even Royal Dutch Shell (NYSE:RDS.A) when they are considering a large oil company for their portfolios. However, it might be a good idea to consider diversifying into one of their smaller peers – ConocoPhillips (NYSE:COP).
ConocoPhillips trades with a valuation that is in line with its peers. It currently trades with a price to earnings ratio of just over 10, and at 1.5 times its book value. Nevertheless, the company did something to set itself apart from its peers a couple years ago. It spun off its downstream business, which refers to its refining operations, into a separate company – Phillips 66 (NYSE:PSX). In doing so, it allowed investors to choose whether they wanted exposure to oil production, which is a business that is highly correlated to the price of oil, or whether they wanted exposure to oil refining, which is a business that depends on the spread between oil prices and refined oil products’ prices (e.g. gasoline, jet fuel, diesel fuel, etc.)
With the spinoff of Phillips 66, ConocoPhillips is now the largest American exploration and production company, and in this way it is set apart from its peers.
The move proved to be a success. Since the spinoff, ConocoPhillips shares have risen by over 30 percent versus its American peers — Exxon Mobile and Chevron — which have risen just 15 percent. The spinoff and the market reaction following it suggest that not only is ConocoPhillips an attractive investment for those investors who are bullish of oil, but it speaks to management’s acumen and its ability to generate value for its shareholders.
ConocoPhillips is going to be growing production by about 3 percent to 5 percent per year over the next several years. Much of this growth is in the United States; in particular, it will be in the Bakken oil fields of North Dakota and in the Eagle Ford shale formation in Texas. However, the company also has a lot of international exposure with a significant offshore exploration project in Senegal spanning 600,000 acres, and with smaller projects in Europe and Asia that will be steady contributors to its overall production.
Despite all of these positives, there are some risks investing in ConocoPhillips. First, while the company is growing production, this growth is slow at 3 percent to 5 percent per year. The company spends a lot of money maintaining its 4 percent dividend and in the past it has aggressively repurchased its own shares. This is great if you need the income, but for longer term investors looking for superior gains, ConocoPhilips is probably not a great investment. Such investors should consider a faster growing company that reinvests most of its earnings into its business such as Apache (NYSE:APA).
Second, there is a lot of political and civilian opposition to oil production in the Bakken and Eagle Ford regions due to concerns regarding hydraulic fracking — an oil and gas extraction process that might be linked to earthquakes. Therefore, in the right political environment, Conoco Philips and its peers could be subjected to punitive regulations that could reduce profits.
But with that being said, the oil market has been extremely strong recently due to rising production costs and tensions in the Ukraine. There is strong support in the mid to upper $90s for West Texas Crude Oil, and the current price is over $101 per barrel. This high price is going to benefit companies such as ConocoPhillips even if they don’t have a lot of production growth. Natural gas prices also seem to have found support in the mid-$4 per million BTU range despite crashing from over $6 per million BTUs in late February. Longer term natural gas prices seem to be in an uptrend, and ConocoPhillips will be a beneficiary assuming it continues.
While ConocoPhillips isn’t the most exciting stock in the oil and gas exploration and production sector, it is a quality name that is going to give investors exposure to a strong energy price market and a rising dividend. This makes is a solid stock for risk-averse investors and for retirees.
Disclosure: Ben Kramer-Miller is long Exxon Mobile and Chevron.
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